Worries over slow response to rate cuts

Leith van Onselen

The Reserve Bank has professed nothing but confidence in its ability to promote growth through interest rate cuts.

You would expect nothing less in public. But behind closed doors there must be pause for thought. To date, the response to the 1.75 per cent official interest rate cuts since November 2011 has been weak, with interest rate sensitive sectors of the economy showing minimal uplift since rates were first cut.

Indeed, compared with past cycles, the response has been poor. The next charts illustrate the situation by comparing the growth of key economic indicators since October 2011 – the month preceding the start of the current interest rate-cutting cycle – against previous easing cycles beginning in 1990, 1996, 2001 and 2008.

First, the growth in the value of outstanding housing credit and the value of housing finance commitments following the latest round of interest rate cuts has been about one-third as strong as the earlier episodes.

Second, new house sales have fallen by about 20 per cent since last October, compared with an average 20 per cent increase in sales at the same stage of the previous three interest rate-cutting cycles.

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Third, at the national level, dwelling values are lower today than they were immediately before the first interest rate cut in November 2011. This compares to an average 13 per cent increase in dwelling values at the same stage of three previous easing cycles.

Fourth, the Westpac-Melbourne Institute Consumer Sentiment Index is only 0.9 per cent above last year's level, compared with an average 18 per cent rise in the index at the same stage of the previous four rate-cutting cycles.

Finally, retail sales have increased by only 3.1 per cent since October 2011, compared with an average 6.4 per cent increase over the four previous cycles.

Overall, the pick-up in economic activity following interest rate cuts has been muted this time around, particularly in housing. This suggests monetary policy has lost some of its potency, which will likely prompt the RBA to make further cuts to interest rates in anticipation of the slowdown in mining investment.

How low? Well, contrary to much media commentary, we are still well above "emergency level" rates. Assuming the banks pass on 0.20 per cent of the latest 0.25 per cent OCR cut, the discount variable mortgage rate would still be 0.70 per cent higher than the mid-2009 low, whereas the standard variable mortgage rate would be 0.55 per cent higher. By the same token, the proportion of aggregate household disposable income devoted to mortgage payments would also be about 1 per cent higher than existed in mid-2009.

While we cannot predict how low interest rates will go, there appears to be scope for another 1 per cent of cuts to the OCR before mortgage rates revisit their lows of mid-2009.